Fifth Circuit rejects “passive investor” test for limited partners
Sirius Solutions, L.L.L.P vs. Commissioner. United States Court of Appeals for the Fifth Circuit. No. 24-60240.
The Fifth Circuit held that “limited partner” in § 1402(a)(13) means a partner with limited liability in a state-law limited partnership, not only a passive investor, and it vacated the Tax Court’s decision.
Holding
The Court ruled that § 1402(a)(13) excludes a limited partner’s distributive share from self-employment tax based on limited liability status in a limited partnership. It rejected the Tax Court’s “passive investor” functional test and remanded for further proceedings.
Why It Matters
This creates a direct circuit-level split in approach with the Tax Court’s Soroban line, which treats “limited partner” as limited to passive investors.
It strengthens the position that state-law limited partnership status and limited liability can control the § 1402(a)(13) exclusion, at least in the Fifth Circuit.
It increases uncertainty for partnerships with active owners holding limited partnership interests because the Tax Court still applies a functional analysis.
It pushes the fight back to statutory text and longstanding administrative practice, not multi-factor role tests.
Timeline
2014–2016: Sirius reported ordinary business income or loss and allocated it to limited partners. It reported $0 net earnings from self-employment.
June 2020: IRS issued an FPAA for 2014. It increased net earnings from self-employment from $0 to about $5.9 million.
June 2021: IRS issued FPAAs for 2015 and 2016. It increased in 2015 to about $7.37 million and left 2016 at a loss.
February 20, 2024: The Tax Court upheld the IRS adjustments based on Soroban.
January 16, 2026: Fifth Circuit vacated and remanded.
Key Facts
Sirius Solutions, L.L.L.P., operated a consulting business based in Houston, with offices in Dallas and London.
It was a Delaware limited liability limited partnership.
In 2014, it had 9 limited partners and 1 general partner. For 2015–2016, it had five limited partners and the same general partner.
Sirius allocated all ordinary business income to limited partners and treated that income as excluded from self-employment tax under § 1402(a)(13).
Statutory or Regulatory Framework
§ 1401 imposes Social Security and Medicare taxes on self-employment income.
§ 1402(a) generally includes a partner’s distributive share of partnership trade or business income in net earnings from self-employment.
§ 1402(a)(13) excludes the distributive share of income or loss of a “limited partner, as such,” but not guaranteed payments under § 707(c) for services actually rendered, to the extent treated as remuneration.
Arguments
Taxpayer argued:
“Limited partner” in § 1402(a)(13) means what it ordinarily meant in 1977: a partner in a limited partnership with limited liability.
The Tax Court’s passive-investor test conflicts with the statutory text and with decades of IRS and Social Security Administration guidance.
Government argued:
“Limited partner, as such,” only covers partners functioning as passive investors.
Federal tax meaning should not turn on state-law labels and should follow economic reality and nationwide uniformity.
Court’s Reasoning
Contemporary dictionaries define “limited partner” by limited liability and limited partnership status, not by passivity.
The “guaranteed payments” carveout assumes limited partners can render services. A strict passive-investor definition would make that carveout pointless or oddly narrow.
Congress knew how to write “no services” or “passive” rules elsewhere in the Code and did not do so here.
Longstanding IRS Form 1065 instructions and SSA regulations defined “limited partner” in liability-based terms for decades, which the Court treated as strong interpretive evidence under the post-Loper Bright framework.
The phrase “as such” can do work without narrowing “limited partner” to passive investors. It can address people serving in multiple capacities, including limited and general partner roles.
Forward-Looking Implications
Partnerships and partners litigating § 1402(a)(13) now have a strong appellate precedent to resist the Tax Court’s Soroban functional test, at least within the Fifth Circuit.
Expect more forum and venue pressure. Taxpayers may try to posture cases for appellate review in circuits that might follow this textual approach.
IRS examination positions built around the “limited partner equals passive investor” framework face a higher litigation risk in Fifth Circuit cases involving state-law limited partnerships with limited liability.
The opinion leaves open how the rule applies to other entity types, such as LLCs and LLPs. That is where a lot of the real money fights live.
Result
The Fifth Circuit vacated the Tax Court’s decision and remanded for further proceedings consistent with its limited-liability interpretation of “limited partner.”
The Takeaway
If your client is a limited partner under state law and actually has limited liability, the Fifth Circuit says § 1402(a)(13) can exclude the distributive share from self-employment tax even if the partner works in the business. The Tax Court’s “passive investor” gloss did not survive in this appeal.
List of Citations
26 U.S.C. § 1402(a)(13): Limited partner exclusion from net earnings from self-employment, with guaranteed payment carveout.
26 U.S.C. § 707(c): Guaranteed payments rule referenced by § 1402(a)(13).
Soroban Capital Partners LP v. Commissioner, 161 T.C. 310 (2023): Tax Court decision adopting the passive-investor functional analysis the Fifth Circuit rejected.
Loper Bright Enters. v. Raimondo, 603 U.S. 369 (2024): Cited for independent judicial interpretation and the relevance of consistent agency interpretations.
Bittner v. United States, 598 U.S. 85 (2023): Cited for skepticism when the government’s litigation position conflicts with prior public guidance.